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Philip Morris USA Inc.

DOMESTIC TOBACCO

Philip Morris USA Inc. (PM USA) achieved solid retail share growth and income gains in 2006. Shipment volume of 183.4 billion units was down 1.1% versus 2005, but was estimated to be down approximately 1.5% when adjusted for trade inventory changes and the timing of promotional shipments.

Operating companies income increased 5.0% to $4.8 billion in 2006, primarily driven by lower wholesale promotional allowance rates, partially offset by lower volume. Results for 2005 included charges for the disposition of pool tobacco stock and a $56 million accrual for the Boeken case, partially offset by the reversal of a 2004 accrual related to tobacco quota buy-out legislation.

Total retail share increased to 50.3%, driven by Marlboro and Parliament. PM USA’s premium focus brands performed well, with Marlboro retail share increasing 0.5 share points to 40.5% for the full year; Parliament retail share increasing 0.1 share point to 1.8%; and Virginia Slims retail share remaining stable at 2.3%. PM USA’s share of the premium category declined 0.1 share point versus the prior year to 62.0%, as gains by Marlboro and Parliament were more than offset by category share losses incurred by other PM USA non-focus premium brands. Premium mix for PM USA increased by 0.5 percentage points to 92.1%.

Marlboro Menthol retained its position as the number two premium menthol brand in the growing menthol category. During 2006, the menthol category grew by 0.5 share points to 27.5% of the total cigarette market. Marlboro Menthol’s retail share was up 0.4 share points in 2006 to 4.4% of the total industry.

PM USA’s retail share of the discount category grew 0.1 share point to 16.4% in 2006, reflecting the performance of Basic in a declining category. For the full-year 2006, Basic retail share declined 0.1 share point to 4.2% of the total retail market, while the discount category declined 0.8 share points to 25.6% of the industry. The deep-discount segment (which includes both major manufacturers’ private label brands and all other manufacturers’ discount brands) declined 0.2 share points to 11.6% of the total industry.

An important area of focus for PM USA is developing products that have the potential to reduce smokers’ exposure to harmful compounds and, ultimately, to reduce the harm caused by smoking. PM USA is making significant investments in research and product development that it hopes will lead to the commercialization of products with the potential to achieve those goals. It also continues to advocate regulation of tobacco products by the U.S. Food and Drug Administration (FDA), in part because it believes that the federal government should establish standards for products that could potentially reduce the harm caused by smoking and define the appropriate ways to communicate these products’ attributes.

Marlboro Smooth

Introduced at retail in March 2007, Marlboro Smooth is a new menthol product offering adult smokers a uniquely rich and smooth flavor choice. PM USA believes that Marlboro Smooth will help build Marlboro’s already strong brand equity in the growing menthol category.

The ability to accelerate growth in the future will be determined, in part, by PM USA’s success in expanding beyond its core business to other tobacco and tobacco-related adjacent categories. Internal development and acquisitions both represent promising and potentially complementary opportunities to achieve this objective.

Internal development provides PM USA with an opportunity to develop new categories by bringing innovative products to market, and to penetrate existing categories with products that enjoy a competitive edge over existing consumer offerings. During 2007, PM USA will introduce a number of new products as a result of its internal development efforts, with an emphasis on products that appeal to adult smokers.